Why Your Money Management Style Is All Wrong

There is a very important difference between managing money and money management. When I explain the difference, you should experience an “ah ha” moment that will set you free of all that bad and confusing advice.

We’re going to take a look at the differences between the two and the mistakes most people make.

After that, I’ll show you how to protect against losing money while achieving returns better than anyone you know.

Money management for the masses

Enter, the financial advisor, mutual fund manager, hedge fund manager, or any other manager you can think of. The first order of business is to recognize who your objectives are lined up with, and more importantly – who they’re not in line with.

Many of these advisors get paid contrary to your best interest. Best explained by a typical example. Mr. & Mrs. Underhill have the basic, simple and common American dream in mind. They are currently working and plan to retire in their early to mid sixty’s.

Upon retirement they would like to move to a nice location with warm weather, play golf, go fishing and enjoy the fruits of their labor from working the majority of their adult lives.

Let’s get a picture of their investment portfolio, retirement accounts and other assets that will help to fuel their desires.

A breakdown of their accounts looks like this:

Checking account where they have their salary checks deposited and pay most of their monthly bills.

Savings account at the same bank where they have some emergency money.

Brokerage account (either with a financial advisor or a discount broker like Fidelity, Schwab or TDAmeritrade.

401K, IRA or other retirement plan, self directed or from their employer.

House.

The value of each asset or account is not important for this example. Extremely important in real life, obviously.

The checking and savings account are straight forward and don’t need much explanation. Same goes for the house, you either have equity or you don’t.

However, the real opportunity to grow their nest egg is in the investment and retirement accounts. Here is where we can’t afford to make critical mistakes.

In the past, the Underhill’s have tried hiring a traditional broker to manage their investment account. He was nice, but never really added any value to their lives and each time the market crashed, they found themselves trying to get back to even. A couple of years ago they opened an account at Schwab and tried to make their own investment decisions.

They bought stocks and funds that were either recommended by Schwab, discussed in the news media like CNBC, Bloomberg or some other outlet.

They both have 401k plans with their employer. They have a list of funds to chose from and don’t pay too much attention to it, thinking “it’s for retirement.” Once in a while, they switch some money into the best performing fund from last year. The accounts have been up and down over the years, along with the market. They contribute regularly, but they always seem to trying to once again, “get back to even.”

Their basic strategy is to try and invest like everyone else, hope the market performs and gives them enough returns to grow their nest egg to the point of “no worries.”

In the end, they’re depending on someone or something else to achieve success.

Managing Money for smart people

Now let’s take a look at an alternative approach.

You need to be the general manager of your finances. It’s your responsibility to set the parameters for the overall allocation of assets into specific areas that accomplish very different goals in the short and long term. Only then, do we begin to decide which categories we can manage ourselves and which ones require outsourcing to a person or company.

Enter, the neighbors, Mr. & Mrs. Bentley. They are very similar in terms of age, income and desires. Very different in terms of assets in their investment and retirement accounts. They have achieved much better results over the years by utilizing a little known system for managing their finances.

They do just about everything themselves except their tax return.

Let’s take a look at how their assets are positioned and why.

They think about their money in terms of three (3) very different buckets.

Bucket #1 – Safe money or rainy day fund. This segment is risk free and consists of only cash, CD’s and other savings accounts that cannot lose value.

Bucket #2 – Swing Trading Account. This is where they make their trades or investments based on signals given by us.

Bucket #3 – Long term investments they need to monitor on a periodic basis, but only have to make changes two or three times per year.

How much and what is really inside these “buckets?”

For simplicity purposes, let’s assume there is 33.3% of their total in each bucket.

Bucket #1 has cash, cd’s at a few banks around town including some treasury bonds purchased online directly from the US Treasury.

Bucket #2 is designated for their trading account. This is where they make the majority of their returns each year being very selective in what they buy, at what price, and most importantly when they buy it. (Shameless plug – go here to see more details)

Bucket #3 is where they have longer term investments such as zero coupon bonds purchased several years ago, a rental property they purchased, gold bullion they keep in the vault at the bank and mutual funds within their retirement accounts (401K plans)

You see, this method almost assures the Bentley’s that buckets 1 and 3 are relatively stable and grow over time, with minimal fluctuation, but also very limited risk.

Let’s take a look at a typical trade from bucket #2 and how they can limit risk.

The bentley’s act on a (hypothetical) trade alert from our service. The alert specifies they purchase Intel (INTC) at $20 per share. They make the purchase at the recommended price using 10% of bucket #2. Let’s assume for this example bucket #2 has $300,000 in total. Therefore, they buy $30,000 worth of Intel at $20 per share for a total of 1500 shares. In this example the target is for Intel to rise by about 7% over the next week or so.

What if the trade goes the other way and begins to decline? That’s where risk management comes in. The Bentley’s will never let a stock trade go down more than 10%. This is where many investors fail miserably. They never want to take a loss and will wait years for a stock to get back to even before selling. While they’re waiting, we make money over and over again.

What does this accomplish? If they were to lose the full 10% on that trade, they’re exposure is one third of one percent of their total savings.

How the math works – $900,000 total portfolio. $300,000 in the trading portfolio. 10% loss of the $300,000 = $3,000. $3,000 is one third of one percent of $900,000.

If the trade is successful, they rinse and repeat the process over and over again throughout the year, allowing all their accounts to continue to compound and grow their retirement funds.

Throughout the year, hopefully they are adding funds to all three buckets. This gives them two opportunities to grow their assets. One by investment gains and the other by saving money and dividing it into the three designated areas.

About the Author

Trading and investing in markets is second nature to some, but a mystery to others. The goal is to provide a forum where everyday people aspiring to be part time or full time traders will learn how view markets differently and profit beyond their wildest dreams.

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